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Volatility Adaptive Trend-Following with Mean-Reversion For Futures

The volatility adaptive trend-following with mean-reversion strategy trades futures contracts in the daily timeframe.

In another article we included a mean-reversion strategy for futures based on our PSI5 algo. The strategy traded long-only ES (E-mini S&P 500), ZN (10-Year U.S. T-Note), FESX (EURO STOXX 50) and FGBL (Euro-Bund) futures contracts.

The PSI algo is based on a formula from a text in probability theory and it is available for sale to professional traders and hedge funds only subject to acceptance of a non-disclosure agreement. The volatility adaptive trend-following algo is offered at a discount with a purchase of PSI5 algo but also sold separately.

In this article we add volatility adaptive trend-following to the strategy. In effect, we limit mean-reversion to time periods when prices are not trending up. We then compare the results to those of the strategy with mean-reversion only.

Strategy backtest settings

Time-frame: Daily (back adjusted futures data)
Strategy type: Volatility adaptive trend-following with mean-reversion, long-only
Contracts: ES, ZN, FGSX and FGBL
Backtest period: 01/03/2000 – 12/24/2019
Maximum open positions: 4
Initial capital: $100K
Position size : One contract or one contract per $100K of equity
Trade entry: Open of next bar (no look-ahead bias)
Stop-Loss: 7%
Correction filter: Price > 200-day moving average

Backtest results

Case 1: Constant position size of one contract

The strategy performed well during 2008 bear market and 2011 correction offering tail risk hedge for equities.

The table below compares the combined strategy (AMAV + PSI5) to the strategy with mean-reversion (PSI5) only and with correction filter.

Parameter AMAV+PSI5 PSI5
CAGR 7.8% 5.3%
Max. DD -28.6% -9.3%
Sharpe 0.76 0.80

The combined strategy provides much higher returns but at higher drawdown as expected. Choosing between the two strategies is a matter of risk preference.

Case 2: One additional contract per $100K of equity gains, 7% stop-loss

The strategy generated high returns in 2008 bear market and 2011 correction with very small increase in maximum drawdown. CAGR is about 75% higher than in Case 1.

The table below compares the combined strategy (AMAV + PSI5) to the strategy with mean-reversion (PSI5) only and with correction filter, when in both cases the number of contracts in increased by one for every $100K of profits.

Parameter AMAV+PSI5 PSI5
CAGR 13.8% 7.1%
Max. DD -30.0% -17.6%
Sharpe 1.01 0.75

The combined strategy with variable position size generated much higher returns than PSI only strategy but at higher drawdown as expected. Choosing between the two strategies is a matter of risk preference.

The stop-loss and correction filter can be adjusted to satisfy different risk criteria. In the article we included only our specific choice, 7% for the former and price > 200-day moving average for the latter.

The volatility adaptive trend-following and PSI5 algos work well across equities and selected futures. Click here for more articles.

Charting and backtesting program: Amibroker

Data provider: Norgate Data

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